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What Every Prospective Homeowner Should Know

Want to buy a home? With both interest rates and housing prices still low, you’re not alone. In fact, we’ve been getting quite a few questions from people looking either to make their first home purchase or to buy a new home after losing their last one to a foreclosure or short sale. If you’re in a similar situation, here are some steps you can take to make sure you’re financially well-positioned to go get (or get back) your little slice of the American Dream.

1. Decide if you’re really ready to be a homeowner.

Contrary to much popular wisdom, owning a home doesn’t always make sense for everyone. I’m not just talking about owning a home you can’t afford (which is always a bad idea). Even if you can, there are some reasons you may be better off renting at least for now. In some areas of the country, it’s still a lot cheaper to rent than to own, especially after factoring in property taxes, utilities (some of which are often included in the rent), and the cost of maintenance and repairs. In that case, you could be better off paying the lower rent and investing the difference. This could be even more true if you’re fortunate enough to live in a rent-controlled area. Not sure if it’s cheaper for you to buy or rent? Check out this nifty calculator.

But the main reason to rent is the flexibility it provides. You don’t want to have to turn down a lucrative job offer just because you can’t sell your home and move, especially when you’re just starting in your career. (In my case, I lived in the Washington DC metro area, NYC, Philadelphia, and San Diego since graduating from college.) If you do sell, closing costs usually eat up any advantages you gain from owning within the first 3-5 years.

On the other hand, there are very real advantages in being a homeowner. You have more control over your home. You can deduct the interest and property taxes from your income taxes. You’re locking in most of your housing costs from growing with inflation. Perhaps most significantly, you’re building equity in an asset that generally appreciates over time and will eventually not have a mortgage payment at all. For a lot of people, this can be the most effective way for them to build wealth because it’s a form of forced savings into an investment that they aren’t tempted to sell every time the price takes a dip (just the opposite, in fact).

2. Check your credit.

Once you’ve decided to buy, you’ll want to do what you can to improve your credit. That’s because it’s one of the biggest factors in determining your future mortgage interest rate that you have some control over. If you haven’t done so in the last 12 months, you can start by ordering a free copy of your credit report from each of the three major credit bureaus at www.annualcreditreport.com and check to see if there are any errors on it that could be hurting your score. About 70% of credit reports have them, so there’s a good chance one of yours does too. If you find anything, ask the creditor to remove it or dispute it with the bureau directly.

Try to get caught up on any payments you’re behind on before they become delinquent and pay down any consumer debt you have as much as possible. You might be tempted to close a credit card once you pay it off, but that can be a huge mistake for a couple of reasons. If it’s a card you’ve had for a while, closing it can shorten your credit history, which hurts your credit score. Second, creditors look at how much debt you have relative to your total credit available. Paying off the credit card helps by reducing your debt, but closing the card can hurt by reducing your total credit available. If your card is costing you a big annual fee, you can always wait until after you close on your home to close the card too.

That all being said, if you have a lot of available credit, you might actually benefit from closing some of those lines of credit so creditors don’t worry about your potential to run up a lot of debt in the future. One way to find out is to use a site like creditkarma.com and quizzle.com. In addition to providing a free copy of your credit score (which you don’t get with your free credit report), you can use these sites to see how actions like closing a card could impact your score. Best of all, these features are free to use.

Paying down debt is generally a good thing, but be careful of making payments on old debts or even contacting the lenders (or more likely, the collection agencies). That’s because you don’t want your actions to turn an old debt into a “new” debt since the latter hurts your credit score a lot more. That doesn’t mean you should necessarily forget them. If you can get them paid off in full and reported as such on your credit report, it will generally help your score after about 2-6 months. Just don’t do so immediately before applying for a mortgage.

3. Save as much as you can.

You’ve probably heard that 20% of the home value is ideal as a down payment. There are also closing costs and you’ll want to have some emergency funds leftover so you don’t run into trouble making your new mortgage payments. No matter how you look at it, the more savings you have, the better off you’ll be.

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Comments

Hey Erik, thanks for your link to CreditKarma.com! Our goal is to make financial information available to the consumer so we really appreciate you spreading the word. I also really enjoyed reading this article- it was super informative and helpful.